Viewpoint: Why Capping Bankers’ Pay Is a Bad Idea

Why the proposed limits on banker pay being considered by the European Union are a misguided – if not dangerous – intrusion of government into the affairs of private companies.

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Jason Alden / Bloomberg / Getty Images

Canary Wharf, the business and financial district in London, Feb. 11, 2013.

I’ve come to dislike bankers as much as the next guy. How can anyone with a sense of justice and fair play not be angry at them? First they tank the global economy with their risky shenanigans, then they take taxpayer money in costly bailouts, then they unrepentantly continue to pay themselves gargantuan bonuses, then they complain about the big deficits and rising government debt that are a result of the recession they caused and the rescues they received. What’s to love?

Still, for me at least, the proposed limits on banker pay being considered by the European Union are a misguided – if not dangerous – intrusion of government into the affairs of private companies. On Wednesday, negotiators for the European Parliament and E.U. member states reached a preliminary agreement to cap banker bonuses at the same level as their salaries. (With shareholder approval, that can be increased to two times the salary.) There may be some wiggle room built into the rules – for instance, some sorts of long-term compensation may be counted differently and allow bankers to earn more money – but the restrictions the E.U. is proposing are still the most overbearing recently considered in the industrialized world.

(MORE: Bankers: Who Needs Them?)

Such measures may soothe the public, but if they are finalized and come into effect, they have the potential to reshape the international banking industry – without making the finance industry any more stable. Ostensibly, the restrictions on pay are an attempt to force bankers to take fewer risks of the type that caused the 2008 financial crisis. Back then, bankers gorged on high-risk but high-return sub-prime mortgage securities that eventually caused the balance sheets of some of the world’s most venerable institutions to implode, rippling through the global economy and sparking the Great Recession. To prevent that from happening again, governments have tried various means to place more restrictions on or improve the oversight of the banking industry, such as the Dodd-Frank reform legislation in the U.S. The E.U. caps on banker pay aims to dampen the incentive of bankers to take excessive risks since they could only earn a certain amount of cash anyway.

Will that work? Not likely. First of all, banks will probably find ways around the rules – by, for instance, increasing base pay – so the link between profits and paychecks won’t be completely broken. (Nor should it be.) More importantly, bankers themselves aren’t the only ones interested in bank performance. Shareholders will continue to clamor for fatter profits and rising stock prices, meaning bankers will still be pressed to post better and better returns – and tempted to take the risks necessary to achieve them. The pay restrictions could also convince bankers to depart from commercial or investment banks and join hedge funds and other, less-regulated segments of the industry.

(MORE: Has the Banking Industry Really Been Fixed?)

Effective or not, the rules could impact the fortunes of the world’s largest banks. What the E.U. is forgetting here is that the financial sector is truly global. The E.U. doesn’t act in a vacuum; the policies it introduces can negatively impact the competitiveness of European banks versus American and Asian banks. Why, for example, would an aggressive banker work in London or Paris and face pay restrictions when he or she could fly off to New York or Hong Kong or Singapore and not have their income capped? Since the new rules are likely to apply to the operations of European banks all over the world, those departing Europe are also likely to depart European banks altogether. That will mean Europe’s banks will be stuck hiring the immobile or the incompetent (or both). And, since the pay caps will also probably be imposed on the operations of American and Asian banks in Europe, they will potentially chase away expert bankers from Europe in general. In the end, the E.U.’s pay caps will likely cause a brain drain out of its financial sector and into its international competition, scare away jobs from a continent desperate for job growth, and place its financial centers at a disadvantage to those in the U.S. and Asia.

We also have to question if capping pay is something governments should be doing at all. However you feel about bankers, you should worry about laws that control their income. How would you feel if the government stepped into your company and mandated limits to how much you should get paid? Chances are you wouldn’t be pleased. The job of allocating pay should be left to a private company’s shareholders. We can argue whether or not the shareholders and directors of banks have been properly doing their jobs, but that doesn’t mean the government should intervene and arbitrarily impose restrictions on the internal compensation decisions of a private institution. People should get paid based on their experience, productivity and results, not on the decisions of politicians or bureaucrats.

The E.U. proposal is effectively a response to the moral hazard governments around the world have created. By treating big banks as “too big to fail,” governments have encouraged risky banker behavior. Why not take a chance and gorge on risk when you know the taxpayer will step in if things turn ugly? Having bailed out the banks, now politicians are looking for other ways to keep them under control. Perhaps the best way to ensure bankers don’t play risky games that threaten national economies is to both allow them to profit from their activities – and suffer for their mistakes.

MORE: Too European To Fail? New E.U. Banking Safety Net Takes Shape

29 comments
JeffreyGeezGlavick
JeffreyGeezGlavick

If you believe these ceo's are worth their absurd bonuses then you also believe in the trickle down theory, so do I, except I know it's urine trickling down not money.

seizeabe
seizeabe

Whether banker pay or CEO pay, in a free market, it cannot be controlled.

Even if a CEO does not take pay, it is not necessary that things will succeed.

Look what happened to Vikram Pandit. He got fired.

CEO is not the permanent friend or the permanent enemy.

Profit is the only permanent friend, and employees are the only enemies.

Till profits rise, CEOs remain. If not they too go.

Employees go, no matter what.

Even when profits rise, employees are fired, to increase profits.

Even when CEO pays rise, employees lose pay or are fired.

There is no CEO who works for his employees.

CEOs work for himself first, and the for the share holders.

And, for government cap, on CEO pay... It is a revolving door.

If you can't understand this, just study the history of people in positions.

Isn't it shameful, that lowest level employees are laid-off and wages lowered, even when organizations make huge profits.

Isn't it shameful, that CEOs get bonuses and huge raises, while lowest level employees are fired or wages lowered, even when organizations make huge profits.

Imagine, banks were being bailed out in 2008, and yet they were paying their top executives huge bonuses... Isn't that the height of shameless audacity.

It was at the same time that the lowest level employees were being fired.

Unless an organization imbibes a conscience of true principles, no mandate will save it from the cycle of greed.

jpmiller99
jpmiller99

Gee, government mandating compensation rules. What could possibly go wrong here???

smjhunt
smjhunt

I think the author is missing a few things.   First, there is a big difference between capping the pay at one bank or a law that levels the playing field.  There's no need to have ever increasing bonuses to get ever increasing performance for sharedholders.  In fast that's one of the problems that this incentive leads them to take big risks.   With the playing field leveled, a bank can't simply jump ship to another bank if they want bigger bonuses. If a bank lags behind the competition, the shareholders can still force the CEO out and replace them with someone who is better at it.  


Secondly, while it is true that the banks will probably try to find creative ways around it, at some point we have to acknowledge that countries are ruled by law and thus so should the banks.   After all, a clever person who wants to kill someone will certainly try to find away around the law but that doesn't mean we give up and not pass any laws against murder.  No, we work over time to close the loopholes. 

KentR
KentR

Any CEO Chairman of board or board member  compensation shold never exceede twice the  entry workers pay rate  bonus included in that valuation  as well as other benefits including health.

rickcain2320
rickcain2320

Congress handles the biggest budget in the world at 3 trillion dollars, yet congressmen make $100,000 a year.    I don't see how bankers pay should be scaled to how much money they move around.

RichardBlackmore
RichardBlackmore

Banks will be left with the incompetent or imobile? How much more incompetent can we get than those who were in charge during the bank disasters? Maybe what will happen is the greedy and arrogant will depart, that would be an upside.

CharlesEdwardBrown
CharlesEdwardBrown

Break the big banks up. Who except the stockholders should care what they pay their executives, but we should not have any bank in the United States of America that is too big to fail. Force the banks to split up and limit their size.

SueDenim
SueDenim

Why are we even debating this.  Screw banks and screw bankers, parasites all.

DeweySayenoff
DeweySayenoff

I've heard this argument before: Don't restrict pay or income at all or people will go somewhere else or do a bad job.  The same argument has been made for raising taxes on the wealthy.  They'll take their money and leave the country barren and a wasteland.

Sorry, but I don't buy it.  Sure, some median-level income person may abscond for greener pastures if it's economically viable for them to do so, but most people find the whole thing way too much trouble to put up with.  Leaving the country (at least renouncing U.S. citizenship) doesn't absolve one of a tax duty, nor will greener pastures in another country entice enough people to up and move to make a difference to the industry.  There has to be a job for them and, frankly, the U.S. isn't a great place for bankers - especially ones from countries where their economic situation is tanking the rest of the world.

With regard to restricting banker's pay, the simple fact is no one is indispensable.  Here's why I say that: Employers have been cutting pay and benefits and increasing hours or duties on their employees pretty much forever, and they still get some schmuck to do the work.  So if there's a job opening, someone will want to fill it because it's likely better than what they have.  And there are a lot of people who aren't in those jobs who could probably do them better than the ones who are.

If the implementation of the plan lends itself to loopholes, then it will be ineffective and I can understand why someone would be against it.  Still, bankers (and pretty much everyone else) need caps on their pay.  How many bankers tanked their banks and STILL got bonuses?  Bankers are EXPECTED to make money for the bank.  Capping bonuses and salaries means they are less inclined to do risky/illegal things (like manipulating lending rates or packaging sub-prime mortgages into investment packages and selling them as low risk investments) to show greater profits because the risk/benefit ratio isn't enough to justify the effort.  Will it create mediocre bankers?  No, because if they don't do their jobs, they get fired and replaced by someone who WILL.

Just like any other employee.

As I said, no one is indispensable.  If someone doesn't like the terms of employment, they can line up with the rest of us in the unemployment line or sit back and rest on their wealth.  They can be replaced and it's likely they'll be replaced by someone who can do the job just as well as they can - if not better.  What's sauce for the goose (the rank and file employee) is sauce for the gander (the management).  After all, as the article pointed out, the investors are the ones who calls the shots.  The management is their employee.

And based on THAT why anyone would take a business public is beyond me.

idknonsense
idknonsense

Without the "intrusion of government into the affairs of [those] private companies," i.e. the bailout, those firms would no longer exist and we would, most certainly, be much worse off today than we are currently.  The "How would you feel if the government stepped into your company and mandated limits to how much you should get paid?" argument is moot because other industries/companies did not cause a global meltdown, nor require government asstance to stay afloat because the alternative meant complete economic collapse.  If governments truly allowed the banks to "suffer for their mistakes," who knows how far down the rabbit hole the global economy would have tumbled.  Any company that requires a government bailout should, absolutely, be subject to compensations dictations.

While the financial industry does provide some necessary services, such as investments essential to innovation and the [hopefully responsible] management of personal and business assets, financial banking is just another job.  A high-level financial banker or trader is no smarter, no more savvy, and no more prestigious than any other professional in any other field.  Yet, they have placed themselves - along with everyone else's help - on a pedestal and created the illusion that they are, indeed, more important to global enterprise than most.  Reality:  they are not.  They do not manufacture useful, tangible goods.  They do not physically help people in need.  They do not teach our students.  They do not get out and build our infrastructure or construct our cities.  They do not clean our environment.  They do not protect our citizens.  They are, simply, another piece of the global pie, of no more (nor of less) importance than the next, and that is the manner in which they should be compensated...just as everyone else.

There is an inherent contract between employee and employer; that is, that employees are paid what they are worth to the employer.  I find it rather difficult to grasp that any employee, of any industry, could honestly deserve (based on the merits of their labor) a bonus worth more than 100% of their base-salary.  If a banking firm genuinely does have some all-star trader who deserves a ridiculous bonus, then that trader should earn a higher base-pay, not get a >100% bonus.  The author, however, claims that raising base-pay is a way around the rules.  It is not, because it would be a part of the rules.  The point of the E.U. proposal is not to break "the link between profits and paychecks."  The point is to establish some kind of ethical responsibility; the kind that was absent when huge banking firms wrecked the global economy, got bailed out, kept their jobs, and, somehow, continued to receive preposterously high bonuses, worth many times their base-pay, because they believed they deserved it.  An employee's worth should be reflected by their base-pay, not by the arbitrarily computed bonuses the may receive.  Outside the financial industry, most people would be happy for a bonus of any percent of their base-pay, let alone the still-huge, 100% base-pay bonus cap proposed by the E.U.

If the E.U. bonus cap is instituted, the claim that "expert bankers from Europe" will flee the continent and "likely cause a brain drain out of its financial sector and into its international competition" is overstated.  Top financial bankers do not solely originate from Europe.  They also come from the U.S. and Asia, and the number European financial bankers who could actually crack into firms outside of Europe is minimal due to the stiff competition.  The U.S. and Asia produce financial bankers who are just as good as, if not better, than their European counterparts, which will make it exceedingly difficult for many European financial bankers find work outside of Europe.

MrBenGhazi
MrBenGhazi

Wholly agree with the author. I can't imagine that this policy is even being considered. Well, then again, it is Europe.

Such a policy, if implemented, would tank the European banking sector, along with the rest of the European and world economy shortly after.

namro
namro

What they and all ceos are paid is irrelevant to some extent.  The issue is what rate they are income taxed at, which should be the highest marginal tax rate.  Their entire compensation package should be treated as ordinary income, which would create a disincentive for all those bogus stock options.  That is the fairness issue, as historically ceos would be paid 12 times average earnings ibn their organiuzatiion.  By 1970 that moved up to 40 times, and peaked recently at nearly 1900 times.

Te bigger issue is the hedge fund managers who are paid commissions that tally proportionately higher, into the billions for the top earners, and pay "carried intrest" instead of the top marginal rate.  It is their incomes that have been propelling ceo compensation.

I believe that the top marginal rate above a threshhold, say $10 million/yr. should be 95%.  This would not only provide more greatly needed revenue to national coffers and help pay down deficits and debt, but would also push the economy toward fairness.

Why are austerity programs mainly targetting social safety nets, jobs and incomes of ther 99%?

antonmarq
antonmarq

Totally disagree with the author, I like to follow the idea that what's good for the gander is also good for the goose. The one sided ideal some bankers follow must be contained or at least seriously curtailed, even with jail time. This not only holds up to bankers but the entire financial and corporate structures that have a fiduciary to the shareholders, the investors, and the public. The abuses need to stop and serious oversight required, even if that controls is done by the government.  

jamesf161
jamesf161

Irresponsible and irrational. There need to be limits on the rewards to prevent these risks, and we can`t let the banks fail because we suffer. And why should shareholders decide pay. It ends badly, and I can`t see a good enough reason to permit it here.

DanielReinert
DanielReinert

Bring back Glass-Stegal.... separate the banking products that can really hurt the economy from the ones that are gambles.  This way we dont have to regulate the bankers when they go to the casino.  The mortgage and savings industry is SUPPOSED to be boring, predictable, with slow average returns.  Let the bankers go gamble with their PROFITS and not with our economy please!  this should help address "to big to fail"

bailey.charlie
bailey.charlie

Why is it that the financial and managerial class of worker is the only one that can consciously withdraw its services and spread rumours about the consequences to national economies, without the same level of public/political ire as striking industrial workers? Its not the same thing, but both essentially operate through withdrawing talent in exchange for better financial remuneration, and yet we don't hold financial workers to be as equally irresponsible? Shame.

bojimbo26
bojimbo26

Like governments they are getting pay , bonuses , gold plated pensions .

US1776
US1776

@rickcain2320 Congressmen's pay is their lunch money.

The real money is skimming campaign finance funds and insider trading.

How else do these guys arrive in Washington with next to nothing and leave multi-millionaires?

.

KenFinch
KenFinch

@idknonsense 

This is so sensible Time should have had you write the article. Instead they choose a pure proganda position and methodology. First the lure the reader into believing they are not going to be presented the same old, same old, basisc bull by accurately describing banking past behaviors. But then they trod out the same old lame , disproven arguments, which I thank you for again  patiently  crtiiticising them accurately.

My criticism is for the pro-millionaire, pro-billionaire propogandists ( who pay for this writing in speaker fees, if not outright bribery)  to just sling their trash from the get go, so I Do not waste my time on such well trodden nonsense.

RichardBlackmore
RichardBlackmore

Because bonuses are limited? If that is all it would take we are doomed anyway. Except it isn't all it would take, because even if we assume this people are worth the trully insane paychecks they get, there is allways somone out there who can do the job at 95% of the effeciency who will take half the pay.

MrBenGhazi
MrBenGhazi

I believe that the top marginal rate above a threshhold, say $10 million/yr. should be 95%.  This would not only provide more greatly needed revenue to national coffers and help pay down deficits and debt, but would also push the economy toward fairness.

Read more:http://business.time.com/2013/02/28/viewpoint-why-capping-bankers-pay-is-a-bad-idea/#ixzz2MD7sIhpS


Then there would be no reason to ever try to earn more than $10 million. The same argument used by the author in the story applies. There would be a massive brain drain to any industry with individuals achieving that level of salary (read: all of them) and we would quickly become outclassed by countries that allow profit.


You can't tax millionaires at 95% if there aren't any to tax.

LesMoore
LesMoore

@jamesf161 The US taxpayer who bailed out AIG is still a 60% shareholder, and as such should decide how the CEO is paid.

rickcain2320
rickcain2320

@bojimbo26  

I work for the government, I'd love to get great pay, bonuses and pensions.    Where can I get mine?

namro
namro

@ZacPetit   Sorry, but that's BS!  People enjoy the power, and I didn't say 100%!  The fact is that even $10 million is too much disparity - notice how since the 1980's average incomes for most people have mainly remained static, while the pay at the top echelons has skyrocketted.  That is unhealthy for the economy - as the 99% are the real job creators through their spending when they have disposable income!

I'm in agreement with most people that there is a healthy level of disparrity, it's just not the current level which is also resulting in the worst level of upward mobility in American history.  Much to most people's surprise, "Socialist" Europe has greater upward mobility today than the US.

rickcain2320
rickcain2320

@LesMoore @jamesf161  

The biggest problem with CEO pay is that boards are made up of CEO's of other companies, which seems to indicate that the entire corporate pay structure is one gigantic conflict of interest.